Options Trade Sees Fed Uncertainty Trapping Financial Shares

Financials have been a strong driver of the rally in stocks so far this year, but one bet in the options market sees them stalling out.

The S&P 500 Financials sector has been by far the best performing of 10 industry sectors this month, adding 7.8%, while the S&P 500 itself gained 3.9%, and the Financial Select Sector SPDR Fund is one pace to finish Thursday at a more than 4 1/2 year high.

But one large options player sees that rally halting this month, with the stock wavering between the level where the financials exchange-traded fund started the month and $21.26 into August.

“It is probably an interest rate play,” said JJ Kinahan, chief strategist at T.D Ameritrade. “They seem to be thinking that with the uncertainty around interest rates, XLF will bounce back and forth in a range over the next few weeks with nothing definitive before August.”

Financials have benefited this month from investor speculation since the most recent Federal Reserve policy meeting that the central bank might move in the next few months to dial back its $85-billion-a-month bond-buying program or raise interest rates from their ultralow levels.

An options trader Thursday sold a strategy known as a “straddle,” which means he or she is looking for the financials ETF to remain range bound over the next 2 1/2 months.

A straddle involves both put options, which grant the right to sell shares at a set price by a set date, and call options, which grant the right to buy them. In this case, the investor sold both 20,000 August $20 puts and 20,000 August $20 calls, collecting a total premium of about $1.26.

For the buyer of the strategy, the straddle is a neutral play that profits from a move of more than $1.26 above or below $20. For the seller, it looks for the shares to remain within the range of $1.26 above and $1.26 below $20 so the options expire worthless, allowing the seller to keep the premium collected on the sale.

At Thursday afternoon’s $20.22 price, that means XLF must not move more than 5.1% higher, or 7.3% lower through Aug. 17 for the trader to profit.

Other big XLF trades Thursday were looking to protect against declines in the months ahead. One investor bought 10,000 quarterly $19.50 puts, which can protect about one million shares of the fund from a more than 4.6% drop through the end of June.

Meanwhile, another investor bought about 40,000 January $17 puts, which protect against a drop below that level through the beginning of next year. XLF last finished below $17 on Jan. 9.